This article presents a conceptual framework describing how the accounting-based earned growth rate metric and the risk-based customer value-at-risk metric can work together to provide a holistic method to measure and communicate the value and ROI of customer experience investments. This new conceptual framework combines EGR as a measure of the value generated from retained customers on the upside and CVaR to measure the potential loss of value from customer churn on the downside.
Consistently delivering exceptional experiences to customers is just smart business, right? On the surface, the virtue of customer-centricity and the value of investing in customer experience, or CX, seem self-evident — conventional logic dictates that the totality of experiences that customers have when interacting with a company influences their purchasing, loyalty and advocacy decisions, which in turn positively or negatively impacts the revenue performance of said company. Despite the general acknowledgment of this very rational value chain, a persistent inability to quantify the value of CX has left many related initiatives, programs and teams vulnerable to the continuously shifting sands of corporate priorities and the specter of budget cuts.
For the intrepid business leaders, marketers, operators and CX management professionals who are accountable for delivering exceptional experiences to customers, there are few topics more pressing than the need to quantify and prove a meaningful return on CX investments. However, simply calculating such a return has proven to be a challenging and often elusive task for several reasons. One of the primary barriers is the inability to consistently show causality between CX and financial performance. Specifically, although CX outcomes can be directly correlated to a variety of underlying factors, such as customer satisfaction, loyalty and advocacy, it is more difficult to establish direct causal relationships between those factors and revenue. Further complicating the CX ROI calculus, it can prove difficult to isolate the specific impact of CX investments from other factors that may be influencing revenue performance, such as marketing campaigns and salesforce effectiveness or changes in the customer, market or competitive landscape. Finally, given the long-term nature of customer relationships, it can take a long time to yield measurable results from CX investments, making it particularly challenging to factor those results into ROI and other financial calculations.
CX ROI and the underlying question of CX value have caught the attention of the greatest minds in the CXM field. Promoted as “the accounting-based counterpart” for the ubiquitous Net Promoter Score and NPS®, earned growth rate was introduced to the world by the venerable Fred Reichheld in his seminal book Winning on Purpose. Although EGR makes a massive leap in terms of creating an accounting-based metric for CX value, it too can suffer from some of the same limitations inherent in conventional CX ROI measurement. Of specific note, both EGR and conventional ROI measurement depend on attributing a share of revenue upside to CX investments, activities and outcomes. While this focus on upside revenue capture is critical, it does not paint a complete picture of CX ROI or value. From this perspective, perhaps the time has come to reframe how we think about, calculate, quantify and communicate the value of CX. This is where a new complementary metric called Customer Value-at-Risk comes in.
Derived from the well-established value-at-risk metric in finance, investments and asset management, CVaR offers a complementary way to measure and express the value of CX. In the context of CX ROI, rather than over-indexing on attributing CX to revenue capture on the upside, CVaR flips the script by expanding the scope of CX ROI by also factoring in the value of preventing revenue losses on the downside. CVaR is essentially a measure of how much a customer is worth to a company and how much revenue the company could lose if that customer decides to take their business elsewhere.
Particularly relevant to the growing number of companies that are attempting to leverage the CXM discipline to make the strategic shift from captive or transactional customer relationships to enduring long-term relationships built to maximize customer lifetime value, CVaR focuses on calculating CX ROI by protecting the downside, preventing the loss of customers. This is important because, according to a study by Bain & Company, increasing customer retention rates by just 5% can increase profits by 25% to 95%. Further, by adding CVaR to calculate the maximum expected or potential loss in revenue from negative customer experiences and lost customer relationships, companies can better understand their potential downside revenue exposure, a crucial element of sound corporate risk management, governance and fiduciary responsibility. From that basis, working as a complement to and in conjunction with EGR, CVaR enables a more holistic picture of CX value and ROI to emerge.
To calculate CVaR, companies first need to identify and measure the underlying risk factors associated with customer churn to estimate the probability and projected revenue impact should those risk factors materialize. For example, excessive levels of effort in digital and customer service channels are key drivers of customer dissatisfaction and disloyalty, making this a key risk factor for losing customers. The metric also takes into account factors like the customer’s spending habits, purchase frequency and length of relationship, along with transactional signals about customer sentiment, to determine the probability of customer defections. Through this lens, companies can focus CX investments on those underlying risk factors — digital and customer service effort, in this example — and quantify the ROI on those investments on the basis of preventing projected customer losses and the potential range of revenue losses associated with those customer defections.
The complementary relationship between the upside focus of EGR as an accounting-based metric and the downside focus of CVaR as a risk-based metric extends beyond pure economics. From an operational perspective, EGR and CVaR both rely on the same underlying experiential factors and the causal relationships that exist between those factors. With the positive impacts on CX reflected in EGR and the negative impacts reflected in CVaR, improving one can improve the other. For example, if a company invests in improving customer satisfaction by increasing first-call resolution in its contact centers, it can likely reduce CVaR through increased customer loyalty and retention. At the same time, those same investments and actions are likely to increase EGR because those satisfied customers are more likely to spend more and recommend the company to others, which leads to higher revenues from word of mouth, expansion and referral sales. Similarly, if the company invests in CX initiatives to increase EGR on the upside, it is also likely to reduce CVaR on the downside.
We can apply the CVaR as a measure of the potential loss that a company may incur from losing customer relationships in its customer base. As a prospective formula, CVaR could be expressed this way:
Expected Revenue (Probability of customer churn * Customer base impacted) = CVaR
For example, the e-commerce division of a national retailer detected a significant reduction in customer satisfaction and a significant increase in customer effort caused by the high turnover of their customer service and last-mile delivery staff. The company estimates that it will generate $500 million in total revenue over the next year. Company leaders assess that there is a 20% chance they will lose 15% of their customer base due to negative sentiment caused by poor customer experiences. Therefore, the CVaR calculation could be expressed as $500 million (20% * 15%) = $15 million. In this scenario, the case for investments in improving customer service and last-mile delivery should be rationalized against a potential loss of $15 million.
Traditionally, companies have quantified the ROI of CX initiatives through the articulation of potential benefits attributable to CX on the upside. Although upside benefits are important, they do not necessarily create a case for action and urgency the way risks do. This is because behavioral science suggests that people are more likely to avoid losses than to pursue gains of an equivalent amount. This is reinforced in Thinking, Fast and Slow, in which Nobel Prize–winning economist Daniel Kahneman illuminates the idea that “in human psychology, losses loom larger than gains.” In essence, people are more motivated by the fear of losing something than they are by the prospect of gaining something. This is referred to as the loss-aversion theory.
The prevalence of this cognitive bias means that boards, CEOs and CFOs may better understand and appreciate the true value of CX investments when they are positioned to minimize potential downside losses to revenue already captured, rather than focusing exclusively on the role of CX in capturing potential gains on the upside. CVaR taps into this psychology by expanding the calculation of CX ROI beyond the upside to create a more holistic articulation of value.
As companies continue to focus on providing exceptional CX and pursuing maximum customer lifetime value, measuring ROI becomes even more critical. Although conventional approaches to measuring and articulating the ROI of CX can be useful, they don’t always give a complete picture of the true value of investing in CX. As a complement to the accounting-based EGR metric, the risk-based CVaR metric can provide a more holistic way to measure and a more resonant way for companies to meet this imperative, and by doing so, put themselves in a position to consistently deliver the elevated experiences that customers expect and deserve and answer the CX value and ROI questions that boards of directors, CEOs and CFOs really care about.
Tom DeWitt and Wayne Simmons are fixed-term faculty members in the Broad College’s Department of Marketing. They both teach courses for the M.S. in Customer Experience Management, and DeWitt is the academic program director of the master’s program and the founder and director of CXM@MSU, an entity dedicated to the global advancement of customer experience management thought and practice.
Net Promoter, NPS and the NPS-related emoticons are registered service marks, and Net Promoter Score and Net Promoter System are service marks of Bain & Company Inc., Satmetrix Systems Inc. and Fred Reichheld.